Thursday’s news that the Federal Energy Regulatory Commission (FERC) will no longer allow master limited partnerships (MLP) to recover an income tax allowance in their regulated cost of service rates drove the group down about 4.5% on the day (the benchmark Alerian MLP Index was down over 10% at one point on an intra-day basis). The policy change, which only impacts regulated interstate oil and gas pipelines and not all pipeline partnerships, can be appealed but our sense is the rule may stick. In effect, the reduced MLP tax burden is being returned to the government.
On the surface, this makes complete sense and was not totally unexpected. These are regulated entities that earn a specified rate of return. However, there were some surprises:
- Some had expected just a notification of intent rather than a final ruling.
- No exemptions were granted.
- No offsets. Some expected some counteraction to limit the impact.
- C-corp structures may be impacted. Natural gas pipeline rates for entities structured this way are under review.
Our investment case for MLPs has been based on U.S. energy production growth, attractive yields, and deregulation. We believe these factors remain favorable, and the transition to more internal funding (and less reliance on external capital markets for funding) is a long-term positive. However, the transition has been bumpy. MLP investors have watched the group struggle as the energy sector has underperformed, interest rates have risen, distribution growth has slowed (part of the transition to self-funding), the new tax law reduced how much interest costs could be deducted, and now as tariffs are being placed on imported steel. On top of that, oil prices may be topping out.
Bottom line, while the bumpy ride for MLPs could continue a little while longer as the market adjusts to these developments, we still believe suitable investors seeking higher-yielding investment options may benefit from exposure to this group.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.
Past performance is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted.
Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. MLPs are subject to significant regulation and may be adversely affected by changes in the regulatory environment including the risk that an MLP could lose its tax status as a partnership. Additional management fees and other expenses are associated with investing in MLP funds.
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships that provides investors with an unbiased, comprehensive benchmark for this emerging asset class. The index, which is calculated using a float-adjusted, capitalization-weighted methodology, is disseminated in real time on a price-return basis (NYSE: AMZ) and on a total-return basis (NYSE: AMZX).
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
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